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The BRIC Debate: Drop Russia, Add Indonesia?

Detractors say Russia's inability to develop into a mature economy merits the country's removal from the BRIC group

Goodbye BRIC, hello BIIC?

In 2001, three years after Russia's ruble collapsed, Goldman Sachs (GS) named the country a member of the BRICs—Brazil, Russia, India, and China—the emerging markets it said would be four of the most dominant economies by 2050. Over the next several years, BRIC-fixated investors piled into Russia as its resource economy thrived in the era of fast-rising oil prices. The BRIC concept still asserts its power. Investors in the $48 billion iShares MSCI Emerging Markets Index Fund (EEM), for example, have nearly half their money weighted in BRIC stocks.

For plenty of money managers and economists, however, the Russo euphoria is all but gone. From Nouriel Roubini to Morgan Stanley, they are calling either for Russia to be ousted from the BRICs altogether in favor of Indonesia or, at the least, for Indonesia to join the other four. They are put off by the policymaking drift in the Kremlin, Russia's demographic atrophy, and endemic corruption. Indonesia's fiscal prudence, economic growth—6 percent this year, according to the International Monetary Fund—and strengthening social and political institutions have far more appeal. Twice-elected President Susilo Bambang Yudhoyono has directed funding toward schools and health care, and Indonesia's coffers are full enough to put the onetime IMF bailout case on the brink of an investment-grade credit rating.

Russia, for its part, cannot seem to escape the investor-unfriendly headlines. Sweden's Ikea has leased diesel generators to circumvent Russian bureaucrats who allegedly demanded bribes to provide electricity to the chain's stores. Then the Swedish retailer revealed that the Ikea executives in charge of leasing the generators were taking bribes, too. Petro oligarch Mikhail Khodorkovsky has been in jail on fraud charges since 2003: His supporters say the charges were trumped up to give the Kremlin an excuse to seize his company. (The government denies this; Khodorkovsky is on trial for fresh charges.) William Browder, chief executive officer of Hermitage Capital Management, once Russia's top foreign investor, was banned from the country in 2006 for tax evasion: He says his company was grabbed by criminals who pulled off the tax scam. "Russia is just not a good place to put your money," says Richard Shaw, managing principal of QVM Group, a South Glastonbury (Conn.) investment advisory.

Shaw says he avoids putting clients in Russian stocks and funds, and steers clear of BRIC-linked investments because of their Russia exposure. He would rather own Indonesian exchange-traded funds: "While Indonesia isn't a paragon of virtue, it's better, especially to participate in the Asian boom." Although some investors want BIIC to replace BRIC, Shaw votes for BICI (pronounced BEE-chee): "It's catchy—kind of sounds like an Italian purse."

Indonesia, the world's fourth-most-populous country and largest Muslim democracy, has corruption, too. In part, that's a legacy of the Suharto dictatorship that ended in 1998. Yet Tom Lydon, president of Global Trends Investments, says the Asian nation has more going for it than Russia. "Beyond natural resources, it is supported by improving domestic consumption, and anticorruption efforts appear to be working." Indonesia has sentenced several politicians and former ministers for corruption. In its latest Global Competitiveness Report, the World Economic Forum ranked Indonesia 44th out of 139 countries—up from No. 54 the prior year. (Russia came in at No. 63.)

While Morgan Stanley (MS) has called for Indonesia to join the BRICs—Goldman has called the country a "Next-11" nation, in a runner-up list of sorts—economist Nouriel Roubini of New York University has argued that Indonesia should replace Russia in the bloc. "From an American perspective," he wrote last year in a column, "Indonesia is an attractive alternative to Russia, which has vied with Venezuela for leadership of the 'America in decline' cheering section."

The iShares ETF allocates just 2.6 percent of its money to Indonesia. That will change, say Indonesia backers; 12 years after its financial crisis the archipelago is China's third-largest trading partner, foreign investment has more than tripled since 2004, and gross domestic product is growing faster than Russia's. While Russia's Micex index has fallen 22 percent from its December 2007 peak, the Jakarta Composite Index is approaching an all-time high. Russia's market fortunes have fallen so low that some investors are taking a second look, especially since Russian corporate profits have been robust. "Russia really stands out as being cheap and attractive," says Maarten-Jan Bakkum, an emerging-market equity strategist at ING Investment Management in The Hague.

Indonesia's supporters say that over the long haul the Asia nation has the edge. More than half of the population is under 30, while aging Russia faces a paucity of productive labor. The Kremlin may have to commit increasing sums to care for the elderly, says Wijayanto, managing director of the Paramadina Public Policy Institute in Jakarta. "Indonesia," he says, "has the potential to become a key global player."

The bottom line: Russia's inability to develop into a mature economy has prompted investors to call for the country's removal from the BRIC group.